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What Buffett Doesn't Get About Newspapers

Local news is even more vulnerable to technological changes than our national media.

Berkshire Hathaway(NYSE: BRK-A)(NYSE: BRK-B) CEO Warren Buffett's decision to buy a hoard of newspapers from Media General seems like a strange one. The world's foremost investor has always been wary of technology, but now he's diving into an industry that's been turned upside down by the Internet.

Almost the entire newspaper industry is on life support, and Media General is no different. The enterprise has lost money in each of its last four quarters and hasn't had a profitable 12-month period since 2007.

Buffett's love of newspapers is well-documented, and Berkshire has been a longtime investor in the Washington Post(NYSE: WPO), which has continued to put up profits by diversifying into education as the media segment has languished. In a letter to Berkshire's media group, Buffett discussed his love for the daily rag, saying he still reads five of them every day. His bet centers around his belief that newspapers "that intensively cover their communities will have a good future," and he calls on his employees to make those papers "indispensable." His core argument for investing in local papers is that they have stronger communities than larger cities because of stable populations. Therefore, the residents are more interested in local news.

But there's a catchBuffett is right when he pinpoints the original sin of newspapers in the Internet era as offering free content online. After all, would you pay to visit a restaurant when they deliver for free? But just because his papers start charging readers doesn't mean we're back in glory the days of folio and ink. The technological changes that are transforming media may actually squeeze local papers tighter than major ones. Here, it seems like his nostalgia for the heyday of newspapers is clouding his judgment.

The major threat to newspapers that charge for online content is from free providers such as blogs, community Listservs, and more established free new media sources such as AOL's (NYSE: AOL) Huffington Post, not to mention classified ads being siphoned off by websites such as Craigslist, which has drained a key source of revenue for local papers.

Unlike national papers, local news covers events in which volunteers could easily substitute for trained journalists. Do you really need a cub reporter at a high school sports game scribbling notes and snapping pictures when plenty of parents would likely be happy to post a few pictures on Facebook or another website and summarize the game in a paragraph or two? Couldn't a concerned citizen sitting in on a school board accomplish the same thing?

You could argue that the quality of the journalism will decline, but that still poses more of a threat to small local papers. Those publications don't have the networks of reporters in far-flung locations around the world or access to sources that the average citizen wouldn't be able to connect to. Smaller cities and towns may have tighter communities than big cities, but news in small towns often travels simply through gossip. The need for a local newspaper just isn't as urgent as the need for media on a large scale.

In what could be a harbinger for regional newspapers, in many small TV markets the three major local news stations have begun sharing all sorts of resources from office space to video to scripts as they compete for limited advertising revenue. The moves underscore the inherent inefficiency of the newsgathering business. Having dozens of reporters at the same press conference seems like bad business when most of them will write similar stories later. Of course, this serves the interest of competition, but in a declining industry, it's obvious that the herd needs to be thinned.

In his letter, Buffett made it clear that he's only interested in buying newspapers with local monopolies, without a rival newspaper. But newspapers have been rolling back coverage for generations ever since they rolled back the afternoon extras as TV news became the major source of late-breaking information. That one newspaper survived in a given community is a sign that the industry has contracted, not of superiority.

Foolish takeawayBuffett's assertion that paying for online content is the way for newspapers to thrive may be borne out. At TheNew York Times(NYSE: NYT), which has struggled to turn a profit in recent years, experiments with a paywall seem to be finally paying off. In just a year, the Times has gained more than 500,000 digital subscribers, or 39% of its weekday print circulation of 1.3 million. Those subscribers helped the New York Times Media Group segment grow circulation revenue by 13% last year, with an estimated 18% contribution to total circulation revenue of $190 million.

Notably, the Times sold a group of smaller regional newspapers last year to focus on its core offering. Morningstar analyst Joscelyn Mackay said at the time, "These newspapers have been a drag on overall results due to heavier reliance on local advertising, which lags national advertising growth." In announcing the sale, Times publisher Arthur Sulzberger Jr. said the decision "will enable The New York Times Company to continue our transformation to a digitally focused, multiplatform media company." That sounds diametrically opposed to Buffett's strategy of looking to local papers as new profit centers.

As the news industry continues to consolidate, it will be the irreplaceable publications that succeed. For local newspapers where the Web is an easy substitute, survival will be difficult.

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